Investment sales volumes in the commercial real estate sector fell nearly 70 percent as the massive economic disruption from the COVID-19 pandemic ground deal making activity nearly to a halt. Data from CoStar and Real Capital Analytics showed a similar drop in magnitude although the latest price indices show only a slight decline in values, evidence that a mass repricing of assets has yet to take place.
Preliminary data from CoStar shows $35.5 billion in closed transactions during second quarter, which is down 69 percent compared to the $113.7 billion in sales during the same period in 2019. Meanwhile, Real Capital Analytics reported a similar 68 percent drop although at a slightly higher volume of $44.7 billion in total sales. The biggest impediment to investment sales is general uncertainty due to COVID-19, including the course it’s taking and impact on the economy, consumer behavior and demand for space. That uncertainty is contributing to considerable challenges in underwriting future income streams and accurately assessing property values and pricing.
“Deal flow continues to fall, and I don’t think it’s going to turn around anytime soon, in part because pricing has only just started to adjust,” says Jim Costello, a senior vice president at Real Capital Analytics. Buyers and sellers have different expectations of where the market is at, and until owners are willing to accept bids that are severely lower than they were pre-COVID-19, there is not going to be many properties trading, he says. Capital also is sitting on the sidelines waiting for discounted distressed assets to emerge.
“We do think there is a bid-ask gap for buyers and sellers, and that feeds into the challenges on pinpointing values,” agrees Andrew Rybczynski, a managing consultant at the CoStar Group. Industry forecasts generally agree on the significant weakness ahead in rental growth across property sectors. However, the dearth of transactions is making it difficult to gauge how property values have shifted.
Another factor contributing to the decline in transaction volume is that owners are simply reluctant to bring properties to market in the current climate. Some properties will be forced to the market by distress. However, any seller in a strong enough position will likely choose to ride out the current downturn rather than attempting a sale, which is contributing to a decline in the amount of for-sale properties on the market, says Rybczynski. Overall, the number of listings added to the market in the first half of the year dipped about 15 percent with retail and office listings diminishing more than industrial or multifamily, according to CoStar.
Searching for bright spots
Some property sectors and geographic markets are proving to be more resilient than others. “Although there is a bid-ask gap on certain assets and in certain markets depending on how properties performed through second quarter, there also are many assets that have done very well and proven their investment thesis on design, location and execution,” notes Matthew Lawton, an executive managing director at JLL Capital Markets in Atlanta. Proven performance, along with new record-low borrowing rates, has resulted in very little price erosion, he says. “You have to be careful when painting certain markets with a broad brush as supply remains an issue near term but is very submarket driven,” he adds.
According to CoStar, hotels saw the biggest drop in transactions, falling by 94 percent to $274.6 million, while industrial fared the best with a 42 percent decline to $8.9 billion. Most industry participants tend to agree that industrial has seen the least disruption from COVID-19. Self-storage is another property type that is holding up better amid COVID-19 pressures as transition, such as job losses that result in moves or college students moving in with parents, tends to drive demand for storage.
Prices for yield-producing self-storage properties have not changed significantly post-COVID-19, notes Ryan Clark, director of investment sales at Skyview Advisors. “We have experienced some bid-ask gaps on deals, but it is not an overwhelming trend in the deals we are marketing,” he says. However, COVID-19 has helped to create a more bifurcated market. Stabilized deals with management value add opportunities continue to receive intense interest as buyers hunt for predictable and stable yield. In contrast, newly developed properties with lease-up risk are seeing a shrinking bidder pool, he says.
And while storage deals are still getting done, in many cases, it is more difficult to get them across the finish line. “Every deal closed post-COVID-19 has required an increased level of advocacy and problem solving on behalf of our clients in order to get from marketing through closing,” says Clark. In addition, difficulty obtaining financing and travel restrictions during second quarter created added challenges and lengthened the overall process to get deals done, he adds.
Notably, multifamily, which has been a hotly pursued sector in recent years, saw a sharp drop in investment sales volume in second quarter—76 percent for CoStar and 70 percent per RCA data. Although unemployment insurance, government stimulus checks and moratoriums on renter evictions have helped to provide a buffer for occupancies and rent collections, there is some concern regarding the negative impact looming once that support disappears. Investors also may be nervous about the active development pipeline that is set to deliver even more supply to the market and the emerge of flat or negative rent growth.
Waiting for pricing discovery
Aside from a proven coronavirus vaccine, one of the keys to kickstarting investment sales will be pricing discovery that helps to bridge the bid-ask gap. Sales that were in the pipeline pre-COVID-19 that proceeded to close in second quarter have helped prop up pricing averages. However, CoStar’s second quarter data is indicating some early pricing weakness, and the firm is forecasting a further erosion in values with the nadir or low point of the cycle likely to hit sometime in mid-2021, says Rybczynski.
RCA also is reporting some slight downward movement in prices. The decline is more noticeable in hotels, with pricing that had started to adjust pre-COVID-19 due to oversupply in some markets. Hotels saw the biggest decline of -1.0 percent compared to first quarter and a year-over-year pricing drop of -5.4 percent, whereas industrial continued to post gains of 1.7 percent over the previous quarter and 7.6 percent year-over-year.
For all property types, the RCA CPPI was relatively flat in second quarter, up a slight 10 basis points compared to first quarter and rising 3.6 percent compared to the same period in 2019. “The pricing shift is not huge given the nature of the economic dislocation, but it is sort of a death by a thousand cuts that we’re going to go through as it could be up to a year of this steady decline in prices,” says Costello.